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Suppose rRF = 4%, rM = 10%, and bi = 1.2. What is ri, the required...

Suppose rRF = 4%, rM = 10%, and bi = 1.2.

  1. What is ri, the required rate of return on Stock i? Round your answer to one decimal place.

      %

  2. 1. Now suppose rRF increases to 5%. The slope of the SML remains constant. How would this affect rM and ri?
    1. Both rM and ri will increase by 1 percentage point.
    2. rM will remain the same and ri will increase by 1 percentage point.
    3. rM will increase by 1 percentage point and ri will remain the same.
    4. Both rM and ri will decrease by 1 percentage point.
    5. Both rM and ri will remain the same

  3. 2. Now suppose rRF decreases to 3%. The slope of the SML remains constant. How would this affect rM and ri?

    1. rM will decrease by 1 percentage point and ri will remain the same.
    2. rM will remain the same and ri will decrease by 1 percentage point.
    3. Both rM and ri will increase by 1 percentage point.
    4. Both rM and ri will remain the same.
    5. Both rM and ri will decrease by 1 percentage point.
  5. 1. Now assume that rRF remains at 4%, but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to one decimal place.

    The new ri will be   %.

    2. Now assume that rRF remains at 4%, but rM falls to 9%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to one decimal place.

    The new ri will be   %.

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Answer #1

a. expected return = risk-free rate + beta * market risk premium

expected return = 4% + 1.20 * (10% - 4%)

expected return = 11.2%

b.

slope of SML is market risk premium which is constant. it means market risk premium = 6% and risk free rate is 5%

it means Both rM and ri will increase by 1 percentage point Option I

c.

slope of SML is market risk premium which is constant. it means market risk premium = 6% and risk free rate is 3%

it means Both rM and ri will decrease by 1 percentage point Option V

e. New Ri = risk-free rate + beta * market risk premium

New Ri = 4% + 1.20 * (11%-4%)

New Ri = 12.4%

2.

New Ri = risk-free rate + beta * market risk premium

New Ri = 4% + 1.20 * (9%-4%)

New Ri = 10.0%

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